Lecture Notes: Multiplier and Accelerator Theories in Macroeconomics

Introduction

• Focus on advanced macroeconomic theories useful for essays.
• Main topics: Multiplier and Accelerator Effects.

Multiplier Effect

Definition

• Multiplier: A process where changes in aggregate demand lead to a greater change in national output.
• Initial increase in Aggregate Demand (AD) shifts AD curve right, increasing national output from Y1 to Y2.

Mechanism

• Increase in spending increases income for others, facilitating further spending, creating a cycle of income and spending.
• Result: Greater change in national output than initial spending increase.

Measuring the Multiplier

• Formula: 1 / (1 - Marginal Propensity to Consume (MPC))
  • MPC: Proportion of additional income spent.
  • MPC ranges from 0 to 1.
  • Example: If MPC = 0.5, 50% of extra income is spent.
• Alternative: 1 / (Marginal Propensity to Withdraw)
  • Includes savings, taxation, and imports.

Example Calculation

• Government injects £100 million; MPC = 0.8.
• Multiplier = 1 / (1 - 0.8) = 5.
• Final increase in national output: 5 x £100 million = £500 million.

Graphical Representation

• AD shifts from AD1 to AD2 due to government spending.
• Further shifts due to multiplier effect, settling at a higher output level.

Determinants of the Multiplier

• MPC is key: Higher MPC leads to a larger multiplier.
• Factors affecting MPC:
  • Culture of saving
  • High taxation
  • High import spending
• High levels of these factors reduce multiplier value.

Accelerator Effect

Definition

• Accelerator: Links changes in investment to changes in GDP growth rate.
• Focus on firm investment rather than consumer spending.

Mechanism

• Increase in GDP growth rate encourages firm investment due to expected future demand.
• Firms invest in new capital, expanding operations with positive growth expectations.
• Negative or slowing GDP growth leads firms to reduce investment, decreasing AD.

Impact on Business Cycle

• Both multiplier and accelerator effects explain the shape of the business cycle.

Conclusion

• Overview of multiplier and accelerator effects, crucial for understanding macroeconomic dynamics.
• Suggested exploration of related advanced economic cycles.